The personal blog of Peter Lee a.k.a. "China Hand"... Life is a comedy to those who think, a tragedy to those who feel, and an open book to those who read. You are welcome to contact China Matters at the address chinamatters --a-- prlee.org or follow me on twitter @chinahand.

Wednesday, August 26, 2015

I suppose much of the journo commentariat was born since
2008 and therefore has no memory of TARP, Too Big To Fail, or Jamie Dimon
rolling around naked inside a gigantic vat of taxpayer money, so there has been
a considerable amount of handwring about how the CCP defiled the purity of
the stock market by flinging a trillion or so RMB at the markets in a faltering
attempt to moderate the collapse of share prices on the Shanghai exchange.

“Purity of the stock market”.Chew on that a while.

I expect the poohbahs of Zhongnanhai are more concerned with
the interesting question of why a few phone calls and a trillion RMB were
unable to stem the decline in a neat, orderly way, and it turned out the best
way to handle the rout was to stand back and let the stock market crater.

And, no, I don’t think the red emperors’ conclusion is “markets
are awesome and all-powerful and the CCP must accept its new role as humble handmaiden
to high finance”.

Here’s a few observations/interpretations.

1. The
bubble had to pop.Valuations were at
ridiculous P:E levels of 60 to 80 and the optimistic "Silk Road Will Save Us" narrative that was supposed to prop up equities and ease the transition to the "New Normal" of lower growth wasn't holding up for international or, I imagine, knowledgeable domestic investors.

2.I think history will judge that the bubble was
fueled not only by gullible small-time investors, but an ocean of money brought
in by the carry trade (borrowing cheap dollars to convert into RMB to chase
high returns in the PRC stock market).Somewhere I read that a trillion
dollars of carry trade money might have made its way into the market.That’s serious money.

3.In my opinion, the PRC situation looks a lot
like Japan in the 1990s.Banks with
underperforming/nonperforming policy/infrastructure loans looked to boost their
bottom lines through carry trade, investment vehicle, and stock trading
shenanigans.

4.A lot of money, smart and otherwise, came into
the market through unconventional funds, margin accounts, and whatnot.

5.The whole stock market spectacle from April to
July looks like a classic pump-and-dump, with big money investors levering up
to boost the bubble and sucking in fish/sheep to be shorn/sacrificial lambs or
whatever hapless animal metaphor you want to call the retail investors whose
primary function, as always, was to get stuck with the funny paper at the end
of the day.

6.When the slide began, in the best time-honored
fashion priority was given to make sure that the big money boys and girls
dodged their margin calls and got closed out of the market at acceptable
levels.The fact that the top securities
companies were entrusted with executing the bailout probably didn’t hurt their
buddies one bit.

7.The CCP wanted and expected the bubble to pop in
an elegantly authoritarian and orderly fashion.When it didn’t, the leadership bought the idea that a disorderly decline
was undesirable, mainly because a spectacularly craptacular market would be
unable to handle the new share offerings intended to wean the SOEs from their
leech-like dependence on the banking system for ridiculously cheap capital.So we got the panicky money-shoveling, the
trading bans, and orders to security companies not to sell their own book.

9.What I expect concerns the CCP is the suspicion that
market control efforts were balked by a lot of things: not just market forces, but
also poorly monitored and regulated capital inflows, and by self-dealing shenanigans
by the securities companies that were charged with executing the bailout.

10.So now it’s time to suppress the forces that
interfere with CCP-mandated market operations.Limit margin, limit short sales, crack down on the unconventional
finance companies a.k.a. hedge funds with Chinese characteristics, and hammer a
few security firm execs.

11.I expect there is a genuine split within the CCP
between liberal reformers a.k.a. believers in the inevitability of oligarchical
market-driven growth & Xi Jinping’s emphasis on controlling and channeling
market and economic forces to buttress CCP dominance.Xi’s aura of omnipotence has certainly taken
a hit.But I don’t think the internal takeaway
is going to be that Xi blew it and Li Keqiang is unfairly taking the fall.I think it will be that liberal reformers
were naïve in thinking that the laissez faire “let a hundred hedge funds bloom”
attitude could deliver a stable, manageable financial sector.

12.Should be remembered that “liberal reformers”
have the ear of the Western press while Xi Jinping probably doesn’t give the
highest priority to what’s written about his economic policies overseas.So it’s important to bear in mind the
distinction between insider tittle-tattle and insider ass-covering.In coverage look for the perennial “Li
Keqiang is an economist, Xi Jinping is just a chemical engineer” tell in order
to get an idea of who’s pushing what.

13.If “liberal reformers” spend too much effort
defending themselves in the Western press, I’m guessing ugly exposes of
corruption, lax regulatory oversight, whatnot by China’s would-be masters of
the financial universe will start popping up in Chinese media and courts.And I expect there’s plenty to play with.

14.The key internal fingerpointing, in other words,
may turn out to revolve around “how did the bubble form so quickly and unwind
so chaotically?” rather than “dang, we shouldn’t have violated the market with
intervention”.

15.I think the market will show some stability now,
not necessarily because it’s reached a rational P:E, but because the insiders
have cashed out and the pressure from the carry trade mechanism is gone with
the collapse of returns on the China stock markets.In fact, one way to look at the RMB
devaluation that appears plausible to me is that the CCP instituted it in order
to break the dollar peg and gut the carry trade.

16.If you really want to get into the financial
warfare weeds, PLA fireeater Maj. General Qiao Liang (who, according to Francesco
Sisci has the ear of Xi Jinping) has put forth the theory, well, accusation, that the United States knowingly pumps up emerging markets
and then crashes them.In this scenario,
the RMB deval would be a pre-emptive move to wind down the carry trade and
deflate the bubble before the Fed yanked out the plug this fall with a rate
hike.

17.The carry trade equation will reverse and we’ll
see capital flight out of PRC into and via Hong Kong, something to remember
when the free-market wonderfulness of the Hong Kong stock exchange is extolled.

18.The CCP can decide if it wants to cherish forever
the big pile of paper it accumulated in trying to prop up the market.I think it would be a great idea to make the
shares disappear—swap them for some crappy debt that is immediately defaulted
on and forgiven—but I suppose the irresistible temptation will be to hang on to
the shares with the expectation that prices will recover and they will be bled
into the market for triumphant “we didn’t lose a mao!” crowing.

19.Bottom line, I think, a major embarrassment for
Xi Jinping, a source of division and discord within the elites, and a big knock
to the financial machinery that will set back reform plans for a couple years.It will also strengthen the hand of the
go-slow factions that, for various interested and disinterested reasons, don’t
want to see the SOE/business as usual/corruption toleration applecart
upset.I expect Xi is currently weighing
the options of either hammering these guys pre-emptively before another
mis-step weakens him further, or cutting his losses and risks by concluding a
truce with his opponents.

20.Regardless of what happens to Xi Jinping’s mojo,
I think the CCP learned an expensive lesson about financial bubbles.And I think the lessons concerning
regulation, monitoring, and control are somewhat different from those free
market advocates in the West would like them to draw.